Beaten-Down Mortgage REITs Face More Uncertainty

The mREIT sector has suffered downgrades over the past week, as taper talk begins to get worrisome again

Last week was a tough one for mortgage REITs, as mortgage rates shot up on the strength of the February jobs report. Then came the analyst downgrades, as Deutsche Bank took New York Mortgage Trust(NASDAQ:NYMT), CYS Investments(NYSE:CYS) and American Capital Mortgage Investment Corp.(NASDAQ:MTGE) down a notch, dropping all three from the prior Buy designation to the current Hold.

To add insult to injury, investment analysts at Wunderlich chimed in on Monday morning, knocking American Capital Mortgage from Buy to Hold, as well.

Down, but not outAll of these players began the current week in the green, apparently shrugging off the downgrades. To be fair, Deutsche Bank noted New York Mortgage Trust's upbeat fourth quarter, and increased its target price to $7.75 – which is just about where the stock had been trading.

Similarly, both American Capital Mortgage and CYS were also valuation calls, with both stocks having regained some of their lost book values. Dividends will be the driving force behind values, the analyst notes, and with 10-year Treasury yields predicted to hit 4% by the end of 2014, price-to-book values are not apt to rise.

Taper talk could reignite worriesBut, the 175,000 jobs the economy added in February could prompt a quicker uptick in interest rates, say some analysts. In addition, the apparent mending of the economy has Philadelphia Fed President Charles Plosser saying that the current pace of the Fed's bond-buying program might not be sprightly enough.

So far, the $10 billion-per-month cutbacks in the Fed's mortgage-bond purchases in 2014 seem to infer predictability; doubtless, markets expect another $10 billion cut will be coming at the Fed's meeting next week. But, what happens if the taper is sped up?

This could conceivably happen. Plosser has suggested that inclement weather last month may have impinged upon job growth, inferring that the jaunty number that drove bond yields up last Friday might have been even higher. While markets may have to wait until the March employment report is released to see whether that theory pans out, a sudden increase in the pace of the taper would doubtless send interest rates higher.

The fear of this occurrence could upend mREITs, much as the concerns about the commencement of the taper last year caused a rout in the sector. If the current predictable pace is suddenly increased – or there are worries that such an event may occur – mREITs could slide, once again.

So far, at least, investors aren't worried. On the fourth quarter earnings call, American Capital Mortgage CIO Gary Kain opined that "a repeat of 2013 is not in the cards." Perhaps he will be proved right.